Gold – Golden Memories

Was going through a very balanced article by Satyajit Das, former banker and the author of Extreme Money: The Masters of the Universe and the Cult of Risk (2011)..where he tried to balance gold in the several parts ..

  • The Return of Gold…
  • Means to a Golden End…
  • Golden Brown Bottoms…
  • Back to the Future…
  • Golden Deaths…

The article started with the replacement of the gold standard with the dollar standard, the gold price has fluctuated widely. In January 1980, the gold price reached a high of $850/ ounce reflecting high rates of inflation and economic uncertainty. Subsequently, the recovery of the global economy saw the gold price fall for nearly 20 year, reaching a low of $253/oz ($8,131/kg) in June, 1999. From 2001, the gold price began to rise due to a number of factors. One was increased demand, especially from emerging nations such as India and China. In 2007/ 2008, gold received an additional boost from the onset of the global financial crisis. In late 2009, gold price renewed its upwards momentum upwards passing $1,200 in December 2009 on its way to over $1,913/ ounce in August 2011. The 500% increase in the gold price since April 2001 prompted gold bugs to speculate about a new age of gold.

In reality, the rise was driven by fear. The depth of the financial crisis, concern about the security of other assets including once risk-free governments bonds and a fragile banking system prompted a flight to gold as a safe haven. The monetary policies of governments and central banks, emphasising low-interest rates and printing money to restart the global economy, also underpinned the gold price.

A weak US dollar and the questionable prospects of other major currencies, such as the Euro and Yen, also drove demand for gold, as de facto currency. Gold does well when monetary and fiscal policies are poor and does poorly when they appear sensible. …

Like other investors, central banks, especially in emerging nations such as China and India, increased holdings of gold. With a large portion of their reserves invested in currencies of developed nations which were losing value, the central banks sought to switch to gold as well as other real assets. In 2009, China announced that over the preceding 7 years, it had acquired 454 tons of gold. It seemed that central banks had remembered J.P. Morgan’s words to Congress in 1912: “Gold is money. Everything else is credit.” – summarizes the return of gold
For investors, investing in gold is not without problems. Shares in gold mining companies may not provide the sought after exposure to gold prices. The value of mining companies behaves more like shares than the gold price. This reflects the company’s operation which may include exploration. The mining company may have investments in other commodity operations which dilutes the exposure to gold. Decisions to hedge the gold price may affect the sensitivity of the company’s earnings to the gold price. There are problems of mergers and acquisitions, purchase and sale of operations, borrowing and sundry issues like mismanagement and fraud. To overcome the problems of physical investment in gold, some banks offer gold “passbook’ accounts especially for smaller investor. Operating like a normal bank account, the facility allows investors to buy and sell modest amounts of gold. The bank pools the investors money and buys and sells gold to match the amounts owed to investors.

Increasingly, investors use gold ETFs, which are an extension of the gold account. The ETF is structured as a mutual fund or unit trust which is listed and tradeable on a stock exchange. Investor purchase fractional shares in the ETF which then invested the money raised in gold. Some ETFs invest in the metal itself. Others synthesise the exposure to gold using instruments linked to the gold price, such as gold futures and derivatives. Some ETF allow leverage, borrowing funds to augment the investor’s contribution to increase sensitivity to fluctuations in the gold price.

Gold ETFs create new risks. Where the ETF uses derivatives and other financial instruments to obtain exposure to the gold, it is exposed to the risk of default by the financial institutions with which it contracts. Even where the funds are invested in physical gold, the metal is held via custodians, often financial institutions, exposing them to the failure of these entities.
The period from 1999 to 2001 is referred to the “Brown Bottom” of a 20-year bear market during which gold prices declined. The reference is to the ill-fated decision by Gordon Brown, then UK Chancellor of the Exchequer and subsequent Prime Minister, to sell half of the UK’s gold reserves via auction over 1999 and 2002. At the time, the UK’s gold reserves were worth US$ 6.5 billion, constituting around half of the UK’s foreign currency reserves.
The gold standard, it is argued, would foster economic stability and prosperity, primarily by creating price stability, fixed exchange rates and placing limits government deficit spending as well as trade imbalances. It will also limit credit driven boom bust cycles through constraints on the supply of money.

The gold standard, opponents argue, would limit the flexibility of governments and central banks in managing economies, restricting the ability to adjust money supply, government budgets and exchange rates. Opponents also point to the inflexibility of the gold standard which may have contributed to the severity and length of the Great Depression.

A return to the gold standard would also confer a natural financial advantage to countries that product gold, such as the US, China, Russia, Australia and South Africa. Geo-political considerations and global competition make this unlikely.

There are also limits to supply. In all human history, only about 140,000 to 170,000 metric tonnes of gold have ever being extracted. Annual production is around 2,400 tones of gold.

The world’s existing stock of gold is equivalent to about three Olympic standard swimming pools. The value of this amount of gold is over US$ 6 trillion, roughly 10% of everything that the world produces in a single year and a tiny fraction of global wealth and assets.
As the metal’s price rose, a Tuscan spa offered wealthy clients a treatment which entails the entire body being covered in 24-carat gold. Costing Euro 420, the treatment, proponents claim, provides unverified benefits such as delaying the visible effects of age, skin hydration and skin elasticity.

Source : Naked capitalism , Satyajit Das

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